Harsh economic realities await the Obama team

The realisation is growing that Barack Obama may already have made a terrible
mistake – before he's even entered the White House.

By Liam Halligan

6:00PM GMT 10 Jan 2009

Five weeks ago, this column raised questions about several members of the incoming President's then newly-unveiled economics team. Weren't they among those history would likely judge as most responsible for causing this crisis? That observation was lost was lost at the time amid the cacophony of praise as mainstream commentators gushed over Obama's "star-studded" line-up.

But since then, among bloggers and others with the "audacity" to think for themselves, the notion that Obama's economics team could become a political liability has started to gain real momentum.

The point at issue is the Glass-Steagall Act – passed in 1933, in response to the Wall Street crash. Named after the two Democrat senators who sponsored it, Glass-Steagall prevented commercial banks – which take deposits from ordinary households and firms – from engaging in high-risk speculative activities undertaken by investment banks.

Or at least it did until 1999 when, after millions of dollars of political donations from Wall Street, it was repealed by President Clinton.

That repeal, more than any other single factor, unleashed the forces that culminated in this financial crisis. Investment banks took over commercial banks using their retail deposit base, on which there was an implicit government guarantee for risky speculative trading – not least in opaque derivatives.

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Wall Street's example, in turn, led to the scrapping of similar regulations in financial centres elsewhere. And we all know what happened next.

One of the main proponents of scrapping Glass-Steagall was Clinton's Treasury Secretary Larry Summers. Removing this crucial banking firewall, he proclaimed at the time, would "better enable American companies to compete in the new economy".

All the repeal achieved, though, was to allow Wall Street firms to engage in recklessly risky behaviour while growing "too big to fail" – sparking today's grotesque taxpayer-funded bail-outs, to say nothing of the freezing-up of interbank markets, blocking of worldwide credit channels and the resulting global slump. Despite his key role in enacting this historic blunder, Summers is to be Obama's chief economic advisor.

Last week, in yet another soft-focus newspaper profile of Summers, one of his academic friends claimed that "when the facts change, Larry changes his mind". Well, Larry, the facts on Glass-Steagall have changed. You and your buddies goofed. So when are you going to reinstate the safeguards upon which the stability of global banking depends?